Discussion Paper

No. 2007-28 | July 10, 2007
The Exchange Rate Targeting of Central Banks Revised: The Role of Long-term Interest Rates

Abstract

Using a New Keynesian macro model, the paper reconsiders the question, whether the central banks should directly respond to exchange rate movements. It is assumed that the transmission of monetary policy to output is carried out by the long-term interest rate, which is determined as a sum of expectations of short-term interest rates and a non-negligible term premium. According to the results, the central banks could gain from stabilizing the exchange rate movements more than suggested in the previous literature. The welfare gains are more clearly seen in the reduced volatility of inflation than stabilization of output, however.

Paper submitted to the special issue "Recent Developments in International Money and Finance" edited by Ronald MacDonald

JEL Classification

E32 E52 E58

Cite As

Markus Lahtinen and Petri Mäki-Fränti (2007). The Exchange Rate Targeting of Central Banks Revised: The Role of Long-term Interest Rates. Economics Discussion Papers, No 2007-28, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2007-28

Assessment



Comments and Questions


Anonymous - Referee Report
October 10, 2007 - 10:33

see attached file


Livio Stracca - Associate Editor's Decision
October 19, 2007 - 14:04

Based on the referee report, which I found appropriate and very comprehensive, I would encourage the authors to resubmit only if they think that they can accommodate the referee's comments in a substantial manner.